Preparing for the Implementation of Sections 871(m) and 305(c)

This paper highlights aspects of sections 871(m) and 305(c) that institutional investors in Canada may wish to consider

Canadian Insights on U.S. Tax Updates

May 2017

Executive Summary

The U.S. Internal Revenue Service (IRS) has released final, temporary, and proposed regulations under IRC 871(m). These regulations incorporate some of the industry’s suggestions with respect to the previously released proposed regulations. In follow-up to our June 2016 paper, “Upcoming Regulatory Changes – 871(m) and the Common Reporting Standard,” this communication sets out practical information regarding the January 1, 2017 implementation date, including insights on the IRS’ final regulations, the in-scope derivative products that CIBC Mellon holds in custody and will perform withholding on, and updates on accounting and accruals. Please note that the following information does not constitute tax, legal, or compliance advice and cannot be relied upon in the discharge of regulatory and/or legal obligations. Clients are encouraged to consult with their legal, compliance and tax advisors for specific guidance.

Introduction to Section 871(m)

871(m) is a U.S. withholding regime designed to address a perceived gap in the current withholding rules. The U.S. government had concerns over investors’ use of derivatives to circumvent payment of U.S. tax on dividends from U.S. corporations. These rules, which took effect on January 1, 2017, are designed to close the gaps by imposing U.S. withholding on dividend equivalents from derivative products with underlying U.S. assets. While the IRS has moved to finalize some of the guidance, there are areas that the IRS has yet to issue final guidance on, and which are still open for comment.

Background Information on Section 305(c)

Related to the 871(m) regulatory change, the U.S. Treasury Department and IRS also issued proposed regulations on the U.S. non-resident withholding tax requirements for deemed distributions payments under Internal Revenue Code (IRC) Section 305(c).

The proposed regulations for 305(c) relate to convertible debt. Conversion price or ratio changes in convertible debt may be treated as deemed dividends subject to withholding. They may also be treated as dividend equivalents under section 871(m).

A withholding agent is obligated to withhold with respect to the deemed distribution under 305(c) only if: (a) the withholding agent has actual knowledge of the deemed distribution before the Form 1042 due date for the taxable year in which the deemed distribution occurred; or (b) the issuer of the convertible Instrument complies with the reporting obligations with respect to the deemed distribution before the Form 1042 due date for the calendar year in which the deemed distribution occurred (a “Withholding Accrual Event”). If a Withholding Accrual Event is attributable to the withholding agent’s knowledge of a deemed distribution, the Withholding Accrual Event will not be deemed to arise until January 15 of the year following the calendar year of the deemed distribution.

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This article is provided for general information purposes only and CIBC Mellon and its affiliates make no representations or warranties as to its accuracy or completeness, nor do any of them take any responsibility for third parties to which reference may be made. This article should not be regarded as legal, accounting, investment, financial or other professional advice nor is it intended for such use.

About CIBC Mellon

CIBC Mellon is a Canadian company exclusively focused on the investment servicing needs of Canadian institutional investors and international institutional investors into Canada. Founded in 1996, CIBC Mellon is 50-50 jointly owned by The Bank of New York Mellon (BNY Mellon) and Canadian Imperial Bank of Commerce (CIBC). CIBC Mellon's investment servicing solutions for institutions and corporations are provided in close collaboration with our parent companies, and include custody, multicurrency accounting, fund administration, recordkeeping, pension services, exchange-traded fund services, securities lending services, foreign exchange processing and settlement, and treasury services.

As at March 29, 2024, CIBC Mellon had more than C$2.8 trillion of assets under administration on behalf of banks, pension funds, investment funds, corporations, governments, insurance companies, foreign insurance trusts, foundations and global financial institutions whose clients invest in Canada. CIBC Mellon is part of the BNY Mellon network, which as at March 29, 2024 had US$48.8 trillion in assets under custody and/or administration. CIBC Mellon is a licensed user of the CIBC trade-mark and certain BNY Mellon trade-marks, is the corporate brand of CIBC Mellon Global Securities Services Company and CIBC Mellon Trust Company, and may be used as a generic term to refer to either or both companies.

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